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Could Venture Debt Be the Bridge Between
Startups in Southeast Europe and Global Growth?

by Etien Yovchev and
Maria-Antoanela Ionita


In recent years, there has been a significant increase in the equity capital available in Southeast Europe, especially in the very early stages –  seed to Series A – there is currently over €400M from 25+ funds available. However, the next growth rounds still tend to be elusive – for one, there are still not that many late-stage investors around, but at the same time founders tend to give away too much equity too early, which makes the closing of later rounds from top-tier international VCs harder. With a few exceptions, the size of a standard venture round in SEE is usually smaller than that in the US and Western Europe. All this means that companies in the region often have to compete for the same global markets with less fuel.

Here comes the potential proposition of the rising venture debt sector. In a nutshell, venture debt is a loan available to VC-backed startups that can be used to complement equity financing and extend a company’s cash runway. 

While this is not a new financing instrument – its origin dates back to the 1970s – it has started growing as an attractive source of funding only in recent years. As a matter of fact, this year has been record-breaking – European startups have raised €8.3B in debt in 2021, compared to €1.6B in 2015.  According to Pitchbook, over $80B in debt products were created for VC-backed startups in the US in the past three years. 

Local examples are also not missing – Bulgarian EnduroSat and Software Group as well as Greek WelcomePickups and Blueground have raised over €65M in debt funding since 2019.  

But why is venture debt becoming increasingly attractive? When is the best time to raise venture debt, and how can it complement equity rounds? Furthermore, to what risks and legal considerations should founders pay attention? Finally, what should you keep in mind when choosing your venture debt lender? 

Given that venture debt is a relatively unknown option with just about 2% market share and plenty of untapped potential in SEE, compared to 16% in the US, in this deep dive, The Recursive will be exploring the answers to these and other important questions. We’ll also discuss more in-depth aspects of the topic together with Donatella Callegaris and Denis Mosolov, Managing Partners at Flashpoint’s Venture Debt fund, one of the most active venture debt providers in Central and Eastern Europe.

How Can Venture Debt Help Your Startup?

First and foremost, what makes venture debt particularly attractive is that startups can get additional liquidity for growth – without giving away control and diluting their cap tables, nor having to justify a high valuation before being ready.

Extended cash runway provides founders with more time to hit the next big company’s value creation milestone and ultimately go for the next equity fundraising round at much more favorable terms. The last bit also matters when startups on a good growth trajectory face unexpected market conditions, say a global pandemic, and need more flexibility in closing their next round. 

Sitting in the space between equity and bank capital, venture debt does come with the requirement for repayment as well as an interest rate (10-13%). Yet, this cost is probably not that high when put into the context with the alternative – giving up an equity stake in a fast-growing company. 

Moreover, equity financing goes hand in hand with hard negotiations on valuation, cap table structure, board seats, etc, all while you’re counting the days of runway left. Venture debt lenders don’t set out to establish a new valuation, thereby the financing process becomes more straightforward.

While traditional banks are normally offering lower interest rates, there are not that many banking institutions that would provide a multi-million growth loan to an unprofitable business that’s unable to provide any significant collateral.

How Can Venture Debt Complement Equity, and How Does It Differ from Bank Financing?

On the spectrum of financing tools that support a startup on its way to exit (M&A or IPO), venture debt has a clear place. If venture capital is the soil that helps the business grow, venture debt is the fertilizer that helps the growing business develop faster, even sometimes despite worsening external conditions, before it’s moved into new soil, ideally in a larger pot. Sometimes it could do without, but often it is just the kick the business needs.

The analogy also reveals an important aspect about venture debt in relation to equity financing: they are complementary. In fact, venture debt experts such as Donatella Callegaris, Managing Partner at Flashpoint VD, will point out that their deals strongly depend on the presence of and relationships with equity investors in the target companies.

“Equity investors like to have someone else who can support their companies when they are still very attractive and need to grow further. It’s about fuelling growth in order to get the Company to the next value-creation milestone and a high valuation, and therefore raise with better investors. 70%-75% of the introductions to the companies that we financed with venture debt came from their existing equity investors. It’s a win-win situation.”

Thus, venture debt is most often placed between two equity rounds, most often after at Series A stage, to fuel growth. Yet in comparison to venture capital, venture debt is a source of cash for the company with none of the control mechanisms. No dilution and no pressure on getting a valuation set. Moreover, considering the associated cost of equity, venture debt is considered a more affordable alternative to fuel growth, even when considering the loan interest.

For all its flexibility, indeed, venture debt is not the only debt funding offering these advantages. Other debt financing, such as bank products, can be seen as alternatives to equity. When it comes to startups, however, venture debt is more accessible and therefore advantageous. Banks are traditionally conservative about lending to startups. Not having the expertise in credit-assessing companies at such early stages renders banks more cautious with both loan sizes and terms of repayment.

Recently, banks have also started offering venture debt products. For now restricted to more mature markets, we can expect them to also reach Central and Eastern Europe. So, what are the differences between what banks and private funds can offer in terms of venture debt? One point of comparison is the cost and here we can expect banks to offer cheaper prices, mainly due to their lower cost of capital. On the other hand, venture debt funds tend to eliminate the need for any financial covenants. For a startup, such freedom from restrictions can be quite valuable especially during its high-growth stage.

“It is true that some traditional banks are beginning to offer Venture Debt-like products, but face three main hurdles.

Firstly, their processes and analysis frameworks tend to focus mainly on the companies’ financials, which, while important, do not tell the full story of a start-up. The quality of its equity investors is a factor which is just as important for the credit story.

Secondly, banks generally require these financials to be audited, which few companies do at this stage of their development.

Finally, few banks are equipped to properly assess and manage the warrants which go with a venture debt loan. Therefore, Venture Debt will always be more closely aligned with the VC universe.”

Denis Mosolov, Managing Partner of Flashpoint VD

Who Is It For and When To Raise Venture Debt?

Usually, startups with proven product, market and business models are the ones that are in a position to take advantage of such offerings. In other words, post-Series A, from 2 to 3+ million euro in annual recurring revenue (ARR), and at least 50%+ growth on an annual basis.

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In practice, there are several main types of candidates for venture debt, like early-stage companies that have raised equity already and are looking to extend the cash runway/ liquidity curve with a more affordable and less controlling option, before raising more equity again – the prospects of which are strong. Other types are startups that have already been backed by credible VCs and are at a stage where the venture debt can take the company to an inflection point – to a position where they can sign a large contract to increase revenue, or improve its valuation position.

The majority of venture debt providers would  support cash flow negative companies but they would still look for indications that the startup has an adequate amount of cash resources to make repayments or it is in a strong position to attract the next round of equity funding.

The Role of Venture Debt in the Financing “Toolbox”: An Interview with Donatella Callegaris

To further understand venture debt in terms of recent developments in Central and Eastern Europe, as well as investor expectations, The Recursive further talked to Donatella Callegaris. Donatella is a Managing Partner at Flashpoint Venture Debt, and the person the Flashpoint Group Board brought in to launch the Venture Debt Fund and lead the Venture Debt team, following her contribution in educating the UK, the Nordics, Germany and most recently the CEE market on the product, as well as years of experience in deal making and building relationships with equity investors in the European and the US ecosystems.

What prompted the company to add venture debt to its asset management portfolio, in addition to equity?

Donatella Callegaris, Managing Partner at Flashpoint VD: The Group Board decided that as Flashpoint is successfully building an asset management business, we wanted to make sure that we support high-growth, attractive technology companies with different products that cater for different stages of their growth story. Sometimes you can miss a Series A equity round opportunity not because the company is not good, but because the timing or the valuation is not right for equity or due to other aspects. But that doesn’t mean that company would not be extremely successful and a “safe credit” for Venture Debt.

The equity team realized that they evaluated so many interesting companies over the years that could have been suitable candidates for Venture Debt and they thought they needed to capture this opportunity and be part of these success stories using another product. They got familiar with how venture debt works, decided to add the product to the Group’s offering, and felt like I was the right person to launch this product in our geo and be instrumental in putting Flashpoint Venture Debt on the “map” pretty quickly.

What are the investment criteria that are important to you in a venture debt deal?

As a venture debt fund, we are probably more open to different sectors. Essentially, it has to be a technology company, backed by venture capital, generating revenue, not necessarily profitable and typically post-Series A. Being VC-backed is our first cushion in terms of security, because if they have a really good investor on board, then it’s very likely that we have a relationship with them, and know that those investors will be likely to support the company going forward. 

If we’re looking at B2B SaaS, for example, I would like to see at least 200K+ EUR MRR, 10-13 months of cash runway, and a growth that is appropriate for the stage and a product and market size that is credible. At the end of our credit analysis we should be in a position to feel confident that the company will continue to attract capital.

In what industries, verticals and business models is venture debt most often used today?

The history of venture debt started in the US. It started with a product that I would instead call “venture leasing” – backing companies with physical assets that quickly evolved together with a big boost of the venture capital ecosystem on the Western coast of the US. And then we saw providers starting to back companies with more value in their IPs and therefore focusing more on software businesses.. 

The DNA of Flashpoint is backing typically B2B SaaS companies. But with venture debt we can also look at software/hardware, marketplaces, e-commerce, as long as there isn’t any inventory risk associated with it. The only thing we don’t do is life science and biotech. The reason for it is because you really need a certain expertise in order to understand and assess those companies.

When would you warn entrepreneurs that it is not safe to raise venture debt?

I wouldn’t raise venture debt too early because it is an amortizing loan that lasts typically 36 months. So if the company is too small, with minimum revenues, it does not make any sense. It increases the risk for us, and for the company, as they would have to use their equity to repay us. In reality, repayments should come in majority from their growth.

If a company comes to me and they have a short runway, I’m very clear to them that they are essentially an “equity risk” and therefore I’m advising them to go back looking for equity VCs, because such a company is not in a position to sustain venture debt. People always appreciate a quick answer even if that answer is a “no” as it could well be a “no, now” but “let’s reconnect in 6/12 months’ time”.

The other situation where companies should not embrace debt is when their revenue is flat or declining. I wouldn’t get into a situation where there is no revenue growth, for the same reasons.

What measures do you take to prevent loan defaults?

Historically, venture debt has a very low default rate, around 2%. The debt is senior-secured which means that we are taking securing over all assets of the company for the length of the loan. We release the security when the loan is repaid. What allows you to have such a low default rate is investing in companies that are growing and are VC-backed. Then you know that if there is a necessity to fund the company between rounds, it is supported by really good investors with reserves for the company as we cannot inject more capital during “rainy days” so we need to work with the existing equity investors to find ways to support the business and help them getting back on track.

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The other protection is that the loan is amortizing. Within 36 months, the likelihood of the company having trouble, if we’ve done our job correctly, is very low. And if it happens half through the loan period, it’s much safer, because we had quite a big chunk of our principal back already.

And then the last resort is the security but you use the security only in extraordinary cases. I have worked on over 130 deals so far and when I have been involved in difficult situations I have managed to find other solutions to overcome trouble and help the companies. During the credit crunch, there were situations where equity investors stopped supporting some of their portfolio companies. In such situations, your security helps you in taking control of the company, take the company as a going concern and work with the founders with the view of selling the business.

There is now more financing available in CEE than ever before. What would you advise funders to do to seize these opportunities and get better financing for their needs?

I am very much into building relationships. I don’t like coming into a deal at the last minute as it becomes “transactional”. The best portfolio companies I’ve ever had have been built by founders that I met a year or six months earlier. So, I’m very much an advocate of identifying opportunities and meeting people early. 

My advice to founders is to just reach out to us even though they don’t feel completely ready yet. A lot of the time, I meet companies that are too early for venture debt. I am more than happy to take half an hour of my time to answer their questions and help them understand if the product will work for them at that point or in the future. And I also help people with introductions to VCs because then I know that when they’re ready for venture debt, it is more likely that they’ll come back to me.

It’s important for founders to understand that they have an entire “toolbox” they can use to build their business all the way to a successful exit. And they should build the knowledge of all the products available and when is the right time to use each one of them.

A lot of education about the market is done at conferences. It has been difficult to settle for the online conferences since the onset of the pandemic. But at live conferences, I usually encourage founders to come to me, have a five-minute chat, talk about the product, and exchange contacts – and when the time is right, to give me a call.

Venture Debt in Action: The Case Study of Mercaux

Mercaux, a New Generation SaaS platform transforming retail stores by seamlessly connecting them to the Digital/ E-commerce world, is a great example of how venture debt can be used by a VC-backed company.

At the beginning of 2021 the reliance on ecommerce for shoppers began to ease as worldwide lockdown restrictions were lifted and stores reopened. This reliance on ecommerce for such a long period of time had accelerated digital adoption for consumers, and so, retailers began to look for digital solutions they could leverage in-store to meet new heightened expectations. At the same time, retailers had used the lockdown periods to upgrade their existing systems and deploy new-age backend systems, readying their business for impending company-wide digital transformation. They were now in the perfect position to engage with companies who could help seamlessly connect their online and offline channels together to provide customers with a connected omnichannel retail experience.

Mercaux, having a single platform that addressed their needs, organically saw an increase in demand and saw an opportunity to accelerate their growth. Naturally, this required resources, and the company explored its options to finance such an opportunity.

While the company was already VC backed and raising additional equity capital was an option, such a step would involve dilution more than what the company could achieve after successfully leveraging the unique market opportunity presented. Venture Debt, on the other hand, allowed the company to raise such capital at a much lower cost and begin riding the tailwinds of market demand.

At this point, Mercaux counts  Nike (IRG),  Tendam (formerly The Cortefiel Group), and Supersports amongst its customers, and its platform is being used across more than 1000 retail locations around the world.

Which Are the Legal Aspects of Venture Debt Deals?

The Recursive team talked to Stephen Polakoff, partner and General Counsel at Flashpoint who has over 20 years of experience as general counsel, legal advisor, and director across various disciplines: joint venture and M&A, capital markets, debt and equity financing, infrastructure, and funds. Here’s what we learned from him.

On choosing the right jurisdiction to avoid complications

While the headquarters of the company can remain in Southeast Europe, founders would find it wise to have the “holding company” or “borrower” in a jurisdiction with clear rules where it is easier to do secured lending transactions such as the US or the UK.

Furthermore, the Venture Debt lender will seek to have ‘security’ so that it has priority over the equity investors and unsecured lenders  in the event of a bankruptcy or any default situation. Therefore, founders would want to have the transaction in a jurisdiction where taking security is fairly straightforward in that you can take a “blanket” security such as a floating charge/debenture in the UK or a security agreement under the Uniform Commercial Code in the U.S.   

Finally, as a key component of a Venture Debt Deal is the issuance by the borrower of a warrant to the lender, the jurisdiction must recognize the concept of a “warrant” or “call option” and such instrument should be able to be exercised quickly without government registration or long waiting periods.

On the most frequent legal misconceptions founders have in respect to venture debt

One of the misconceptions is that Venture Debt is like a “convertible loan”. This is not true for two main reasons.

1) Convertible loans convert into shares of the borrower at the next equity round. Therefore, the documents are not drafted as true loan agreements as the lender treats the investment as a “quasi equity” investment rather than as “true debt”.  In other words, the investor in this instance does not have an expectation of having the principal and interest on the convertible loan repaid.  The investor wants the equity.

2) Because this is a debt instrument and the lender expects to be repaid in cash, the lender will always ask for security such as a pledge over assets or intellectual property or bank accounts. 

What are the main questions founders should ask their venture debt lawyers?

The main question is whether or not their counsel has experience with Venture Debt transactions and standard terms of a Western style loan agreement such as the form of loan agreement developed by the London Market Association (LMA).  Only with such background will the lawyer be able to advise the founders on how to respond to the requests of the Venture Debt provider with respect to transaction structure and covenants.   The Venture Debt provider is focused on ensuring that the company will have sufficient cash flow to repay the debt and that in the event of a default, the Venture Debt provider is “senior” to other creditors.   

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The startup lawyer should review whether there are convertible loans in place and if the lenders of such loans can demand repayment in cash at maturity or earlier? If yes, then the repayment of such loans will need to be postponed beyond the maturity of the Venture Debt loan or be repayable solely with shares otherwise key cash flow is coming out of the company prior to repayment of the Venture Debt loan.  Does the company have existing bank credit loans or secured lending? If yes, the Venture Debt provider will want clear provisions subordinating such debt to the Venture Debt loan or, if there are secured loans that cannot be subordinated,  then intercreditor agreements to ensure the orderly enforcement of security and declaring events of default. 

In addition, the company’s lawyer needs to understand what types of transactions the company will need to carry out after the drawdown of the Venture Debt loan in order to grow its business. For instance, such transactions could be additional financings (such as working capital lines or acquisition finance) and entering into certain material transactions such as acquisitions or joint ventures.  The company’s lawyer will need this information to negotiate “carve outs” to the negative covenants that will be included in the Venture Debt loan.  Again, this comes back to the key issue – that the lawyer representing the founders understands the Venture Debt structure and the standard covenants and provisions that any provider of Venture Debt debt would expect.  Once the legal teams of the lender and the borrower can speak the same language and have a clear understanding of the needs of the company to grow, the documentation process becomes more efficient and less costly for both sides. 

On the best approaches when you can’t repay the loan

No provider of Venture Debt wants to put its borrower into default as this limits the ability for the Venture Debt provider to achieve a return on its investment and it is very bad for the reputation of the lender since they made a “bad choice”.  Therefore, the company should come to the lender as early as possible once it is clear that there is a potential problem with cash flow and seek to “restructure” the loan by extending the maturity period, providing further security, having the equity investors “top-up”, etc.  The startup needs to understand that it is a “team” effort.

On deciding who’s the right venture debt provider

Usually the terms of Venture Debt transactions are structured in a similar manner.  Therefore, leaving aside pure commercial terms such as interest percent/size of the warrant, the startup needs to determine whether or not VC debt makes sense rather than a convertible loan or a “bridge” equity round.   Prior to signing a term sheet or discussing a potential Venture Debt loan, the startup should engage the correct advisors who understand the structures of the various options and the pluses and minuses.   

What’s Next for Venture Debt in CEE?

In CEE, Venture Debt funds expect to see an increasing product uptake, driven by more Western European and US investors coming into the market, the growth of VC late stage, and a  better understanding of the product, among others.

Foreign investors are attracted by a startup ecosystem that is coming of age. Strong technical talent and business resourcefulness in the region had produced over 34 unicorns to date, with a combined value of 186B in 2021. The positive flywheel effect is expected to draw more and more investors into the scene. And more VC funding also means more potential borrowers for venture debt providers, especially when the startup has strong investor backing at later stages, which diminishes risk for debt providers. 

In fact, in Europe, the preference for Venture Debt amid a startup’s financing tools is growing. Even if it’s been around for over 25 years – half the time compared to the US – in the first half of 2021, venture debt was used in a larger proportion vs. equity in Europe compared to the more mature US market. 

The growing interest in Venture Debt is also confirmed by large institutional banks. The European Investment Bank launched its full-scale venture debt operations through the European Fund for Strategic Investments in December 2016. And although the processes differ under such large institutions – taking longer approval times for instance – it helps popularize venture debt as a key financing instrument for European startups. 

Foreign investors bringing knowledge into the market together with effort to educate founders and equity partners by regional players like Flashpoint will also help surpass one of the biggest obstacles with using venture debt: the missing or incomplete knowledge of the product. 

The main stigma associated with it is that it resembles other debt financing such as bank instruments, when in fact venture debt providers advise entrepreneurs to treat it more like equity. Moreover, in Eastern Europe, in particular, people have historically avoided taking any type of loans, given the prolonged austerity regimes countries had to adapt to. Presently, the mindset is beginning to shift towards more openness to debt financing, as its benefits outweigh negative perceptions.

Nevertheless, the lack of understanding of the product, as well as the lack of a relationship-building mindset will continue to act as entry barriers in CEE hence why the education of the market is key. One of the main difficulty with offering venture debt is also in understanding the differences in jurisdiction and how to legally structure a deal across different countries hence why dealing with experienced and well established venture debt professionals, with a strong and long lasting reputation in the market like we have at Flashpoint, will help the startups to smoothly navigate the negotiating, closing and funding stages of their venture debt financing round and benefit from the added value that they should expect, says Donatella Callegaris.

By most indicators, we expect to see Venture Debt develop from a new-school investment strategy to an essential tool in the financing “toolbox” of startups with global growth aspirations.